UK: Public Policy And The Limits Of Insurability

The rules of public policy relating to acts "uninsurable by law" give insurers, in effect, an automatic exclusion that overrides the contract.

It is an ancient principle of English common law that no person may benefit from his own wrong. In the insurance context this has been applied to preclude recovery by an insured of an indemnity against the consequences of his own deliberate crime. There is, however, a marked lack of authority considering the application of the prohibition beyond deliberate crimes. Most of the few cases were decided in previous centuries in very different circumstances, and there is a lack of modern authorities.

It seems to us that the ambit of the prohibition should be as follows:

• Criminal wrongdoing. The consequences of deliberate crimes are uninsurable. Many professionals are, however, subject to criminal offences based on negligence or even strict liability. Some very old authority suggests that any criminal conduct is uninsurable, but the modern position is probably that the prohibition will only apply to nondeliberate crimes which the court considers "sufficiently anti-social".

• Civil damages. The prohibition probably applies to civil damages resulting from deliberate or intentional wrongdoing. What counts as ‘intentional’ for these purposes is likely to depend on the specific context, and may therefore import the same "sufficiently anti-social" balancing act. Recklessness may be sufficient in some cases, but in others actual intent may be required not only in relation to the wrongful act but also the specific loss.

• Regulatory fines and penalties. The same principles should apply: the courts will not assist recovery of regulatory fines imposed for deliberate wrongdoing, but should do where the wrongdoing was ‘merely’ negligent (especially where the fine is in the form of compensation that goes to the "victims"). Many regulators, however, prevent reliance on insurance in other ways: the FSA has a general prohibition in its rule-book, whereas the SEC prefers to approach the issue on a case-by-case basis, where possible by agreement.

The following general points concerning the application of the prohibition are reasonably clearly established:

• The prohibition does not apply to purely vicarious liability for the deliberate wrongdoing of an employee or agent: the relevant wrongdoing has to be by the principal itself.

• Insurers are entitled to look behind the particular way the claim is put to the real facts giving rise to the liability and, in general, assuming they can prove it, insurers can allege fraud even if the claimant does not.

• The prohibition applies in principle to defence costs as well. However, different considerations may arise, depending on, for example, the precise trigger for advancement in the contract and any ‘final adjudication’ restriction in the dishonesty exclusion. In the regulatory context, the FSA rule-book permits insurance for defence costs (even though not for fines), although other regulators have been known to take a harsher line.

• The prohibition only applies to enforcement: there is nothing to stop an insurer from paying the indemnity if it chooses to do so (which it may, for example, in the captive context). Insurers that do not take this point may, however, find their reinsurers resisting payment.

How would the English courts apply the prohibition in cases involving significant international aspects? We venture the following:

• Conduct only illegal under foreign law. The English court is likely to apply the prohibition in the same way to deliberate conduct that is illegal or wrongful under the law of the country where that conduct occurred, even if it is not illegal or wrongful in England.

• Indemnity enforceable under foreign law. The parties may have chosen an applicable law that, unlike English law, would in fact allow an indemnity to be enforced in respect of deliberate wrongdoing. Save in exceptional cases, however, an English court is likely still to apply the prohibition, as to do otherwise would permit the parties in effect to ‘contract out’ of English public policy.

• Indemnity unenforceable under foreign law. This is the converse to the above. An English court is likely to allow an indemnity to be enforced even if it is unenforceable abroad provided that it is normally enforceable here. There may be an exception in the relatively unlikely case where the only possible method of performing the contract would be illegal abroad – but usually alternatives will exist, such as effecting payment outside the relevant jurisdiction.

We would add that there is nothing to stop an insurer from providing in its policy for the best of both worlds, by expressly applying the public policy restrictions of both English and one or more foreign laws.

How do these principles apply to an entity, such as an LLP or a company? Traditional "innocent partner" clauses in professional indemnity policies, for example, may not work in the same way for corporate entities as they do for individuals.

The prohibition against allowing an indemnity to be enforced will apply to an entity where the court treats the acts of certain individuals as if, for legal purposes, they were the acts of the entity itself. This "attribution" happens easily in situations giving rise to vicarious liability, for example employer/employee; and this will not prevent an indemnity from being enforced. That requires "personal" liability of the entity itself, for which much more restrictive rules of attribution apply. One of the common tests for this is who was the corporate entity’s "directing mind and will" in relation to the acts in question, but this concept can mean very different things depending on the particular context.

The high-water mark for insureds probably came with the 1999 case of Arab Bank v Zurich, which concerned a liability policy that indemnified a company and its directors. There, the dishonesty of an insured who was the managing director and significant shareholder of a company (also an insured) was attributed to the company for the purpose of the company’s liability to a third party, but was not attributed to the company so as to preserve the company’s right to recover under an indemnity.

So just how far can an insured have its cake and eat it? The result in Arab Bank partly reflects the underlying rationale of liability insurance: to ring-fence each insured’s right to indemnity from being prejudiced by other insureds, and also to protect third parties injured by the insured’s wrongdoing.

Equally, however, the decision turned on the particular provisions of the insurance policy involved in that case. Policy forms, and classes of insurance business more generally, approach these issues in a variety of differing ways; and indeed, some traditionally say nothing at all about attribution. With the rise of LLPs as professional service providers, however, this is an area of increasing importance, which places emphasis on fitness for purpose of provisions concerning, for example severability, attribution and dishonesty exclusions. As always, therefore, the exact policy language may be crucial, particularly when the court is considering the application of public policy.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.